Question

A firm is considering borrowing​ $1

million at an annual interest rate of​ 6%. Assume that before considering this capital restructuring​ , the firm has total debt of​ $4 million at an annual interest rate of​ 7% and annual depreciation expense of​ $400,000. Assuming EBIT of​ $600,000, what is this​ company's cash coverage ratio​ (a) before; and​ (b) after the proposed​ restructuring?   

A. ​3.57; 2.94

B. ​2.94; 3.57

C. ​7.28; 14.29

D. ​5.00; 14.29

A firm has been offered a loan of​ $5 million from two different lenders. Lender A would charge an annual rate of​ 6% whereas Lender B would charge a rate of​ 8%. Assuming annual EBIT of​ $600,000 and annual depreciation expense of​$400,000, what would be the​ firm's cash coverage ratio if it undertook the loan from​ (a)

A. ​2.00; 2.33

B. 3.33; 2.50

C.​ 2.50; 3.33

D. 2.33; 2.00

Lender​ A; and​ (b) Lender​ B?   

Answer 1

First question

The correct answer is option A. ​3.57; 2.94

Cash coverage ratio = EBITDA / Interest

EBITDA = EBIT + Depreciation = 600,000 + 400,000 = 1,000,000

Before restructuring:

Before considering this capital restructuring​ , the firm has total debt of​ $4 million at an annual interest rate of​ 7%

Interest = 7% x 4,000,000 = 280,000

Cash coverage ratio = 1,000,000 / 280,000 =  3.57

After restructuring:

Interest = interest on old debt + interest on fresh debt = 280,000 + 6% x 1,000,000 = 340,000

Cash coverage ratio = 1,000,000 / 340,000 = 2.94

Hence, the correct answer is option A. ​3.57; 2.94

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Second question

The correct answer is option B. ​3.33; 2.50

Cash coverage ratio = EBITDA / Interest

EBITDA = EBIT + Depreciation = 600,000 + 400,000 = 1,000,000

From Lender A:

Loan $ 5 mn at 6% interest rate

Interest = 6% x 5,000,000 = 300,000

Cash coverage ratio = 1,000,000 / 300,000 =  3.33

From Lender B:

Loan $ 5 mn at 8% interest rate

Interest = 8% x 5,000,000 = 400,000

Cash coverage ratio = 1,000,000 / 400,000 = 2.50

Hence, the correct answer is option B. ​3.33; 2.50